Market Perspective

Inflation Soars, But Is It Only Temporary?


Overview: Over the past week, the big story was much stronger than expected inflation data. The reaction from investors was surprisingly small, however, and mortgage rates ended the week with little change.

 

The Consumer Price Index (CPI) is a widely followed monthly inflation report that looks at the price change for goods and services. In May, core CPI, which excludes the volatile food and energy components, jumped 0.9% from April, well above the consensus forecast for an increase of just 0.5%. Core CPI was 4.5% higher than a year ago, up from an annual rate of increase of 3.8% last month, and just 1.6% in March. This was the highest reading since 1991. The big question is whether the pickup in inflation is mostly due to temporary factors or longer-term influences.


Looking more closely at the categories that experienced the biggest price gains helps explain why some economists believe that much of the inflation increase is transitory in nature. In recent months, pent up demand has caused particularly large gains for cars, airline tickets, and similar items affected by the pandemic. For example, used car prices in June were a shocking 45% higher than a year ago, due to a surge in demand and supply shortages for key components such as chips. Looking forward, though, no one expects that used car prices a year from now will be anywhere near 45% higher than they are now. Chip manufacturers will get caught up over time, which will allow car makers to run at full capacity, and supply and demand will be balanced more evenly. In short, the extreme conditions caused by the pandemic will gradually ease.


On Wednesday, Federal Reserve Chair Jerome Powell delivered his semi-annual testimony to Congress, and it contained no surprises. Powell said that the Fed’s goal of achieving “substantial further progress” toward full employment remains “a ways off.” Regarding inflation, he noted that it will likely remain “elevated in coming months before moderating.” Investors took these comments to mean that the Fed will not speed up its timeline for tightening monetary policy due to the latest inflation data.

 

Core CPI (annual % change)


Week Ahead

July 16 — Retail Sales report

July 20 — New Residential Construction report (aka Housing Starts)

July 22 — Existing-Home Sales report

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